Chevron: a Unique Opportunity

Shares of Chevron (CVX) have bounced back after falling to its lowest point of $78.98 a share on January 20, this year. This growth in its share price performance is by and large driven by positive talks between Iran and OPEC to limit oil production in order to boost crude oil prices.

The positives

According to a report released by Yahoo Finance, Iran affirms any procedures to support oil prices turmoil.

Its oil minister said, “The country supports "any measure" to boost oil prices and voiced its support for a plan to stabilize and boost prices laid out earlier this week by four influential oil producers.”

More importantly, the other OPEC members such as Saudi Arabia, Qatar, Russia and Venezuela came together and reached an agreement to limit their crude production, after understanding the special situation of Iran for Western sanction. However, these members said they would only adhere to this course of action if the other members of OPEC agree to cut their crude oil production.

Even so, this positive sign from OPEC members will positively impact crude oil market in the world. This is due to the fact that after a significant drop in crude oil production from non-OPEC members this year, the OPEC members have joined this struggle of fighting against the drop in crude oil prices. As per Energy Information Administration, the non-OPEC members are expected to curb their crude production by only 1% in 2016 and 0.3% in 2017 respectively.

On the other side, EIA anticipates the crude oil production from the OPEC region to grow 3% to 39.20 million barrels in 2016 and an incremental 2% to 40.07 in 2017 respectively. However, this forecast was issued by EIA couple of weeks before the positive talks between Iran and OPEC members on February 17, 2016.

In my view, the recovery will take quite before than understood. Let us assume if the OPEC members cut their crude production by 0.4 million barrel per day in 2016 and 0.57 million barrel per day in 2017, yet increasing their crude production by 1.6% and 1.8% in 2016 and 2017 respectively.

Strong long-term prospects

Moreover, the demand for oil and gas is expected to remain stable in the long-run. As per the energy outlook released by BP for 2016, the demand for oil is forecasted to grow steadily at 0.9% per annum, while the demand for gas is projected to rise by 1.8% per annum. Although, the demand for oil is forecasted to slump relative to gas, yet it remains strong due to fast growing emerging economies.

So, the overall oil and gas fundamentals appear to be strong going forward that should enable Chevron to drive growth for its business and its shareholders. In fact, Chevron is taking a variety of actions to further optimize its production and increase efficiencies for its assets. These strategic measures will assist the company to maximize its profits when the uptick in the oil market takes place. Let us have a look at these strategic measures.

Cost reduction for its upstream segment

During this dead oil price environment, the company purposefully reduced its operating expenses and capital expenditure particularly for its upstream segment that helped the company to partially put better results on the board for 2015. These reductions have been realized through a mixture of initiatives such as leverage of purchasing power, supplier reduction by negotiation, rebidding of key contracts, rationalization of business units and right-sizing of headcount. Also, the operating efficiency initiatives like reduction in drilling days and lowering of downtime led to a 30% reduction in days per 10,000 feet in 2015 versus 2014.

Looking ahead, the company is expected to reduce its operating costs in the range of 13% to 18% in 2016. It is aggressively implementing incremental costs saving projects at Gulf of Mexico, Thailand and Tengiz. Also, it is reducing vendor and contract costs, constructing critical infrastructure and increasing engineering maturity that should contribute positively to its effort of reducing costs and expenses.

In addition, the company is reducing its capital expenditure in order to preserve cash and improve its financial flexibility. For instance, its capital expenditure for the year came in at $29.5 billion, a decrease of $6.00 billion from 2014 levels. Looking ahead, the company remains on track to further reduce its capital expenditure as major capital projects have been completed and outlays ramped down.

Apart from this reduction in capital expenditure, the company has generated approximately $5.7 billion through asset sales in 2015. This brings its total proceeds to $11 billion in the past two years. Going forward, the company plans to further dispose its non-core assets of $5 billion to $10 billion in 2016 and 2017. These strong proceeds will help the company to pay down its total net debt that stood at $27 billion at the end of the year.

Conclusion

Chevron is making significant progress to revive its upstream segment through various costs reduction and operating efficiency measures. Moreover, it is investing in the growth projects that has lower development costs and better returns on the capital employed. These projects will enable the company to drive growth for its upstream segment once the recovery in the oil takes place. On the other side, the oil fundamental looks pretty strong in the long-run that should allow the company to take risks such as funding its dividend through borrowing, despite the lower operating cash flow. CVX had generated nearly $4.6 billion of operating cash flow in the fourth quarter and $19.5 billion for the year as against total expenditure of $29.5 billion in 2015.